What It Really Costs To Mine Gold: The SilverCrest Mines First Quarter Edition

SilverCrest Mines (NYSEMKT:SVLC) offers investors a producer with some of the lowest true all-in costs in the industry. With a gold-heavy production portfolio, these low costs will allow the company to be profitable even in the current low price precious metals environment. While many competitors in the gold and silver industry report negative second quarter incomes, SVLC should still report positive earnings and continue to be profitable. Additionally, a strong balance sheet gives the company much leeway in terms of its development objectives.

The company-specific challenges that investors should monitor are the company's transition from open-pit mining to underground operations and its impact on grades and true all-in costs. Additionally, investors should monitor share issuance to make sure SVLC does not issue too many shares - which has hurt investors significantly with other junior miners.

If SVLC can maintain its true all-in costs at current levels in its transition to underground operations and keep share issuance flat or at a minimum, we believe that this miner could offer investors good upside and be a mainstay of any portfolio of junior miners. Additionally, if SVLC can continue to increase reserves and expand its Santa Elena deposit, then it can provide investors with significant upside without the downside risk associated with cash-negative junior miners.

We believe so far management has done a good job earning the trust of investors so they should view SVLC's underground mining transition with some optimism. Thus SVLC offers investors a gold miner with a strong balance sheet, positive earnings and very good upside.

Introduction

In an earlier article, we discussed one of the most important metrics to analyze the gold industry, the actual cost of mining an ounce of gold, which can help an investor figure out whether it is time to buy GLD and/or the gold miners. In that analysis, we used the FY2012 financials to calculate the combined results of publicly traded gold companies and came up with a true all-in industry average cost of production to mine each ounce of gold.

Note: Even though many investors classify SilverCrest as a silver miner, we classify them as a gold miner. This is due to the fact that the great majority of SVLC's revenue (around 70%) comes from gold sales, thus the company is much more sensitive to the gold price and not the silver price. If future production changes we will change the classification accordingly.

Calculating the True Mining Cost of Gold - Our Methodology

In the previously mentioned article, we gave a thorough overview of the current way mining companies report their costs of production and why it is inaccurate and significantly underestimates total costs. Then we presented a more accurate methodology for investors to use to calculate the true costs of mining gold or silver. Please refer to that article for the details explaining this methodology, which is an important concept for all precious metals investors to understand.

Explanation of Our Metrics

Cost Per Gold-Equivalent Ounce- is the costs incurred for every payable gold-equivalent ounce. It is Revenues minus Net Income, which will give an investor total costs. We use payable gold and not produced gold, because payable gold is the gold that the miner actually keeps and is more reflective of production. Miners also use payable gold and not produced gold when calculating their cash costs, so this is pretty standard.

We then add Derivative Gains (or minus Derivative Losses), which will give investors total costs without the effects of derivatives. Finally, we add Foreign Exchange Gains (or minus Foreign Exchange Losses) to remove the effects of foreign exchange on the company's costs.

Cost Per Gold-Equivalent Ounce Excluding Write-downs- is the above-mentioned "Cost per gold-equivalent ounce" minus Property/Investment Write-downs and Asset Sales. This provides investors with a metric that removes exceptional gains or losses due to write-downs and asset sales.

Cost Per Gold-Equivalent Ounce Excluding Write-downs and Adding Smelting and Refining Costs- is the above-mentioned "cost per gold-equivalent ounce excluding write-downs" adding in smelting, refining and all other necessary pre-revenue costs. This is a new metric that we are now introducing to our true all-in cost series because it will more accurately measure all-in costs and allow comparisons between miners.

Most investors are unaware that many miners will remove smelting, refining and other costs before reporting its total revenues figures and these pre-revenue costs are not reported in the income statement. The result of this is that it skews all-in costs higher for miners that refine themselves or include the costs in their income statement while inaccurately showing lower costs for miners that remove it before reporting revenues.

A simple test can be done on any miner to see if there are any pre-revenue costs that are not reported in the income statement. Simply take payable production and multiply it by average realized sales price and this should come relatively close to the total revenues figure. If it gives you a number much higher than reported revenues then there are pre-revenue costs that are not being reported.

This line should alleviate these issues and allow comparisons on a fair basis.

Real Costs of Production for SVLC - 1Q13 and FY2012

Let us now use this methodology to take a look at SVLC's results and come up with their average cost figures. When applying the methodology for the most recent quarter and FY2012, we standardized the equivalent ounce conversion to use the average LBMA price for Q4FY12. This results in a gold-to-silver ratio of 53:1. We like to be precise, but minor changes in these ratios have little impact on the total average price - investors can use whatever ratios they feel most appropriately represent the by-product conversion.

Notes about True All-in Costs Table and SVLC Calculations

Though SVLC had no write-downs, it does have a contract with Sandstorm Gold to deliver 20% of Santa Elena gold output to Sandstorm at below market prices. The details of this contract are beyond the scope of this article, but we do include the difference between the estimated spot price for the quarter and the sales price to Sandstorm as an exceptional expense in the "write-downs and exceptional" expense line.

Observations for SVLC Investors

True Cost Figures - SilverCrest Mines has had an excellent cost structure over the past year which ranks it close to the top of all gold miners in terms of true all-in gold costs. In the most recent quarter, SVLC produced gold with a true all-in cost of $1045 per ounce - which is a very strong number. This compares to competitors as Yamana Gold (NYSE:AUY) (costs just over $1300), Goldcorp (NYSE:GG) (costs just under $1200), Newmont Gold (NYSE:NEM) (costs around $1300) Agnico-Eagle (NYSE:AEM) (costs around $1400), and Barrick Gold (NYSE:ABX) (costs around $1200).

Note: We have just recently started including the smelting and refining costs for most miners (including SVLC). For the reports on SVLC's competitors mentioned above, we did not start including these expenses - so these miners'; expenses may be higher when including these costs. When we issue the full first quarter gold miner comparison we will show these expenses for all miners.

SVLC's $1045 Q1FY13 true all-in cost number was higher than its 2012 average of $932, but as investors can see it is still top of the class in terms of mining costs. We believe future realized tax rates will be higher, but this should not keep SVLC from being one of the lowest cost producers in the industry.

Management has done a superb job at keeping costs low, but with any company we like to make sure we also see the future challenges that face the company. If you do not know the challenges that your company faces then you really do not know the company very well.

The biggest company-specific challenge that SVLC faces is the transition from open-pit mining to underground operations. We believe this transition is expected to begin in early 2014, and investors should monitor the cost structure of the company related to underground operations - we expect costs to be higher. But SVLC management has done an outstanding job so far at keeping costs low, so we will optimistically give them the benefit of the doubt in a successful transition.

Corporate Liquidity - Liquidity is very important for investors to monitor in this current low-price gold environment. SVLC has a strong financial position with $21 million in cash and cash equivalents, $20 million in short-term investments, and just over $10 million in precious metals inventory. Couple this strong liquidity with a cost structure that keeps the company relatively profitable even at these gold prices, and we find that SVLC is very well-positioned to survive in this gold environment.

Production Numbers - SVLC's first quarter production of 7,225 ounces of gold was below its fourth quarter gold production of 7,831 ounces, which was one negative to the quarter. Though, silver production was pretty much flat at 153,000 ounces for the quarter. Management forecasts 2013 production to come in at 625,000 ounces of silver and 33,000 ounces of gold - at this point silver production is on target but gold production will need to increase to meet these figures.

One thing that may increase 2013 production (and help SVLC meet its outlook) is the construction of the new 3,000 tonnes-per-day mill, which is on schedule and on budget - so we would not read too much into the lower first quarter production numbers.

Conclusions for Investors

SVLC has been one of the lowest cost gold miners in the industry and is a company that many investors may overlook. Producing gold at true all-in costs of $1,045 per ounce keeps its profit margins relatively high even at current gold prices and investors do not have to worry too much about liquidity with SVLC. Production numbers are relatively stable and may rise when the new mill is built and used in production. Additionally, Silvercrest's name causes many retail investors to classify it as a silver miner when currently the majority of its revenues are derived from gold sales.

Investors should carefully follow the company's transition to underground mining, but so far Silvercrest has demonstrated that it is a true low-cost miner that should make a good addition to any gold investor's portfolio. Additionally, if management can continue to increase Santa Elena gold and silver reserves (they just increased them in May) this company may be significantly undervalued at its current price of $1.80 per share.

Compared to other miners in the industry, we believe SVLC offers investors a company with good upside, a healthy balance sheet, and one of the lowest cost structures in the industry - which gives it the ability to weather the current low gold and silver price environment.

Disclosure: I am long SVLC, GG, PHYS, SGOL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.